The Series I savings bonds offered by the U.S. Treasury are a means for consumers to invest in low-risk securities. Series I savings bonds also enjoy several tax benefits that are unavailable for most other fixed-income investments.
These bonds are non-marketable, meaning that they cannot be bought or sold on a secondary market.
- Series I savings bonds are not taxable at the state and local levels, but they are taxable at the federal level.
- Investors facing a tax liability may use the cash method and pay in a lump sum when they cash out of these bonds, or they may use the accrual method and pay regularly as interest payments create a tax liability.
- Series I savings bonds are not taxable at all if they are used for qualified educational expenses.
- Series I savings bonds have the same tax benefits as Series EE savings bonds.
I Bond Taxation Basics
Before getting into the special exemptions, here are the basics of I bond taxation:
- Series I savings bonds are not subject to state or local taxes. When you invest in Series I savings bonds, you won't pay state or local taxes on the interest income you earn. That means that more money ends up in your pocket at the end of every year than if you were to own an ordinary bond.
- Series I savings bonds are subject to federal taxes. When you buy your Series I savings bonds, you will owe the federal government taxes on the interest income you earn during the time you hold it. This is due to the fact that the Series I savings bond is a special type of bond known as a "zero-coupon," meaning that you won't receive regular checks in the mail; instead, the interest you earn is added back to the bond's value, and you'll earn interest on your interest.
- You have a choice between one of two taxation methods: the cash method or the accrual method. The cash method means that you will only pay tax on your I bonds when you redeem them (i.e., sell them back to the government). If you hold your bonds for 20 years, then you won't pay any tax during that period, but you'll owe a tax when you sell out of the investment. If you opt for the accrual method of taxation on your I bonds, you will pay the tax that is due on the interest you earned for the year that was added back to your principal.
Using Series I Bonds to Pay for Education Expenses
You won't pay any tax on the interest income you earn from your Series I savings bonds if you use them to pay for qualified educational expenses and meet the income limits. Qualified educational expenses include tuition and fees, such as required lab courses, to a university or college. They also include expenses paid for any course required as a part of your degree program or certificate-granting program. The expenses must be incurred on behalf of you, your spouse, or a dependent for whom you claim an exemption on your taxes. You are required to use both the principal and the interest income from your Series I savings bonds to pay qualified expenses.
The costs of books or room and board do not count as qualified expenses.
Other Ways to Avoid Paying Taxes
There are several other conditions for paying no taxes on your Series I savings bonds.
- The I bonds must have been purchased after 1989.
- You must pay for the qualified education expenses in the same tax year you cash in your Series I savings bonds.
- You must be at least 24 years old on the first day of the month in which you bought the bonds. If you were 18 years old, for instance, you wouldn't be eligible to use the Series I savings bonds to pay for your or your family's college costs; you'd still be stuck with the tax bill.
- If you are using your Series I savings bonds to pay for the college education of a child or other minor whom you name as a dependent, the bonds must be registered in your and/or your spouse's name. You can list your child as the I bond beneficiary, but you cannot list them as the owner. Otherwise, you won't get the tax exemption on the I bonds when using them to pay for college.
- If you're married, you and your spouse must file a joint tax return to qualify for the Series I savings bonds tax benefits.
- You must meet the income limits set forth by the Treasury Department to qualify for the tax benefits of the Series I savings bonds. You may have to make a few detailed calculations to find out whether you qualify. IRS form 8815 can help. For 2020, the interest deduction phases out at $82,350 modified AGI and is completely gone at $97,350. For married joint filers, the tax benefits are reduced at $123,550 and are completely gone once your modified adjusted gross income exceeds $153,550.
- The college, vocational school, or university must meet federal assistance standards, such as the guaranteed student loan program. Otherwise, you won't get the Series I bond tax exclusion.
It's important to understand that the Series I savings bond tax benefits will be reduced by the amount of any scholarships, fellowships, employer-provided educational benefits, or other forms of tuition reduction, according to the Treasury Department. These will be deducted directly from the qualified educational expense calculation.
If the value of your bonds exceeds the number of your qualified expenses paid during the year, the amount of interest you can exclude on your taxes is reduced pro-rata. That is why you may want to consider acquiring several smaller-denomination paper Series I savings bonds instead of a few larger-denomination bonds. You can redeem them in smaller batches to prevent that from being a problem.
Series I Bond Tax Benefits Compared to Series EE Bond Tax Benefits
The Series I bond tax benefits are identical to those of Series EE savings bonds. If you own both as part of your fixed-income portfolio, your calculation should be much simpler to perform when it comes time to cash in your bonds and pay a tuition bill.
More About Series I Savings Bonds
You can find out more in the Guide to Investing in Series I Savings Bonds, which will walk you through more information on savings bonds, especially the Series I savings bonds, and will explain how you can add them to your portfolio, annual purchase limits, ownership requirements, tax benefits, and much more.